Living Paycheck to Paycheck? Stop It Using Profit First Method

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I know exactly what it feels like.

For years after getting my PhD I lived paycheck to paycheck, with $31k a tight squeeze for a family of 4.

It was a long, hard slog to get out of that helpless feeling, one minor “emergency” from getting sucked into a debt spiral.

I would obsessively review our budget each month, trying to figure out how to reduce our spending by maybe $50, only to see the following month that we hadn’t met my more frugal goal.

Over the decades since we’ve come a very long way, and I can finally say I feel rich. I only wish I could have read back in the day something that would have been incredibly helpful, and that I read a few years ago (since it only came out in 2014).

Read on for the ultimate step-by-step guide on getting out of the paycheck-by-paycheck trap.

A Small-Business Finance Book that Can Be So Much More

It’s the #1 best-seller in Amazon’s Small Business category.

Mike Michalowicz’s “Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine” (not an affiliate link) is a highly readable small-business finance book full of actionable advice.

If you’re building a 7- or 8-figure business and haven’t already read it, clear 3-4 hours in your schedule and read it asap!

The big idea of the book is to systematically disconnect the incoming-money pipe from the outgoing-money pipe of your business.

Do this in your private life, and you’ll almost certainly find yourself more than halfway to getting out of the “paycheck to paycheck” trap.

Michalowicz recommends each business open 7 checking accounts across 2 banks, and “When in doubt, add an account.” This is incredible overkill for solo businesses, which is why I developed a tweak for such small businesses.

Opening 7 checking accounts for your personal finances is even more ludicrous. But that’s not what I’m suggesting. As I describe below, I want you to implement Michalowicz’s big idea into your personal finances, not all the details of his method.

But first, let’s peer “under the hood” of Profit First to understand what makes it so powerful.

Why Profit First Works

To borrow from the book, imagine you come to brush your teeth in the morning. The tube of toothpaste is brand new and full. You place a generous squeeze of paste on your brush, and off you go.

Now imagine it’s a couple of weeks later. The tube is nearly empty, and you realize it’s your last tube of toothpaste, and you don’t have time to run to the store. You can’t squeeze the same generous amount onto the brush as you did a couple of weeks ago, because there’s less than half that amount left.

What to do?


You squeeze a minimal amount of paste onto your brush, and make do. In fact, if you had to, you could probably stretch that last bit of paste for another 2-3 days. Right?

Michalowicz suggests you artificially create that same sense of scarcity in your business finances by:

  1. Having all revenue come into one business checking account
  2. Twice monthly, moving a predetermined fraction of the total revenue you received in the prior half month into a separate “operating expenses” account, and deciding that no matter what, you won’t spend more than what’s in that account
  3. On those same occasions, moving the rest of the revenue into other accounts, as set-asides for paying quarterly taxes, for your profit distribution, and for building up a cash reserve

As the half-month proceeds and you pay bills for your business, your operating expenses account balance drops. If you’re several days short of the next transfer date and you realize your spending balance is close to zero, you reference the toothpaste scenario.

You reduce your daily spend and stretch out the little bit that’s left until you buy a new tube of toothpaste, errr, make your next twice-monthly transfer into the operating expenses account.

By setting your finances like this, you force your business to live within its means, while setting aside enough to cover expenses, build a rainy-day emergency fund, and even leave enough to provide for a profit distribution you can enjoy.

Can things still go wrong?

Of course.

If your revenue drops significantly and you have non-discretionary expenses (e.g., rent, utilities, web hosting, etc.) that you can’t easily change, you’ll lose money. But…

  • Since you’ll have started stretching your resources, your burn rate will be lower
  • Since you’ll have started setting aside money for a rainy day earlier, you’ll have extra resources to cover you until things pick back up
  • Since your tax set-aside will have been based on your full expected profits, even some of that set-aside can be repurposed to cover irreducible expenses

As a final piece, Profit First suggests a reviewing all your business expenses and figuring out which can and should be stopped, which can and should be replaced with something comparable but less expensive, and how to gradually reduce even expenses that can’t be stopped or replaced.

But more on that below…

How to Set Up the Profit First Big Idea in Your Personal Finances

As I mentioned above, I don’t recommend opening 7 checking accounts for your personal finances.

However, I do recommend using 2 checking accounts (call them “Income Checking” and “Expense Checking”) and 1 savings account (call it “Reserves Account”).

Here’s how you set it up.

  • Have any income deposited into “Income Checking”
  • Periodically, transfer money from “Income Checking” to “Expense Checking” to allow you to cover your expenses; and transfer the rest from “Income Checking” to “Reserves Account” (more below on how frequently and how much to transfer)
  • Pay all bills and statements from “Expense Checking” only
  • If and when you see the “Expense Checking” balance is dropping too low relative to the time left until the next transfer, slow down your spending
  • Keep track (using software like Mint or Quicken, an Excel or Google spreadsheet, or even a notebook) of money in the “Reserves Account” by 3 categories: tax set-aside, emergency fund, and money to be invested

How to Review Your Personal Spending and Reduce It in 5 Steps

There’s no denying it.

This next piece will be the most challenging, especially if budgeting and numbers aren’t your thing. But believe me, it’ll be worth the effort!

Step 1

If you’re like most of us and use your credit cards and online payments for most things, print out the most recent statements of all your credit cards and accounts. If you use cash for much or most of your spending, start writing down daily how much you spent and what you spent it on, and come back in a month to the next step.

Step 2

Review your statements and/or notes line by line.

Mark each line K for “Keep,” R for “Replace,” or S for “Stop.”

Here’s how to tell which should be what.

If it’s something you have no choice about (think rent or mortgage), or it’s a high priority (think tithing for your church, if you tithe, or any spending that makes your life worth living), it gets a nice big K!

If it’s something you enjoy, but that you could replace with something less expensive without too much suffering (think downgrading your cable bundle to basic TV only and signing up for a lower-cost option like Amazon Prime, Netflix, Hulu+, and/or Apple TV), it gets an R.

If it’s something you just got into the habit of paying for but don’t really need, or that doesn’t align with what’s truly important to you (say a paid subscription you don’t really use anymore), it gets a big red S.

Step 3

Cancel everything marked with a red S. Just stop spending anything on these items. They’re not important for you, and not worth the time you spend making the money they cost, and the stress it brings.

Step 4

Replace everything marked R with the lowest-cost alternative you can find that satisfies your needs.

In extreme cases, you could consider doing this for your big-ticket items like housing and transportation by moving to a less expensive house and/or buying a smaller, less expensive car. However, these more extreme steps are rarely feasible (e.g., you may be in the middle of your lease term, and/or may not be in the market to replace your car), so if they’re not, don’t sweat it.

Step 5

Sum up all the costs marked K, along with all the costs that replaced the ones marked R. Multiply this number by 0.97. That’s your new spending cap.

Since you can’t simply notify your landlord that your rent payments starting next month will be a bit lower, you’ll need to reduce discretionary expenses by more to make up for it.

If you don’t think you can survive on 3% less than you’re spending now, think of what you’d do if you suddenly lost your job, or took a 10% pay cut. You’d figure out a way if you had no choice. You do have a choice though, so I’m suggesting you cut spending by just 3%.

You may need to go back to Step 2 and move some things from K to R, or from R to S.

Alternatively, you may need to figure out how to earn more through overtime, a side hustle, a promotion, or a new job or business.

Repeat this whole process every 3 months for a year, and your spending will be at least 11.5% lower. If you had anything at all in categories R or S, your spending will have dropped even more.

How to Figure Out When and How Much to Transfer out of Your “Income Account”

When Do You Make the Transfers?

If your income is all from one paycheck, you’ll make the transfers on each payday.

If your income is based on periodic payments (e.g., clients pay you each time you see them), make the transfers on the 1st and 15th day of each month.

How Much for Taxes?

This depends on your income source.

If you’re a W2 employee, your employer likely already deducts money for taxes from each paycheck. If so and you have no other income, you probably don’t need to set anything more aside for taxes.

If you own a business, you’d ideally work with a CPA and have him or her tell you how much you’ll need to pay each quarter. Use that to calculate how much you need to set aside each month for taxes. Note that quarterly estimated taxes (in the US) are usually due mid-month in April, June, September, and January. This means you have 3 months to save up for the first quarter’s payment, 2 months for the second quarter, 3 months for the third quarter, and 4 months for the fourth quarter.

If you don’t work with a CPA and don’t have a better system, set aside at least $0.30 from each dollar of revenue for taxes.

You may think this is too low, since you probably have to pay 12-24% (or even more, up to 37%) just for your federal taxes, plus 15.3% for self-employment taxes, plus potentially up to 13.3% for state and local taxes, which could total over 50%!

However, that percentage applies to your profits, not your revenue. If you pay rent and other business expenses, and qualify for the 20% Qualified Business Income Deduction, your taxable income will likely be lower than your revenue by enough that 30% of the latter is enough to cover your taxes.

If you find yourself slightly short the first time, adjust from 30% to 35% from that point forward. On the other hand, if you find that your taxes are lower than what you set aside, reduce from 30% to 25% (or even less as appropriate).

How Much for Emergency Fund?

Building an emergency fund holding at least 3-6 (and preferably more) months’ worth of expenses is a great way to avoid the stress I felt all those years ago, when we were one minor unplanned expense from dropping into a spiral of debt.

If you have no emergency fund at all, make this your top priority after taxes, and set aside nothing for investing until you have a month’s worth of expenses.

If we assume $0.30 from each $1 of revenue goes to taxes, and you keep your spending under $0.50 of the remainder, you have $0.20 left over for each dollar of revenue.

Set aside that 20% toward your emergency fund for 3 months, and you’ll have enough to cover over a month’s worth of spending. At this point, split the 20% in two, with 10% continuing to build up your emergency fund and 10% going to investments for the future.

By the end of the first year, your emergency fund should cover 3 months’ worth of your initial expenses, and if you followed Steps 1-5 above, your expenses dropped (say by 20%). That means you actually have enough to cover almost 4 months’ expenses.

By the end of Year 2, you have more than 6 months’ worth of your current expenses in your emergency fund. It’s time to drop gear on that part, reducing it to 5% (or even 0% if you’re happy with 6 months’ worth).

The remaining 15% (or 20%) now goes to accelerating the growth of your investment portfolio.

How Much for Investing?

As mentioned above, until you have a month’s worth of spending in emergency savings, set nothing aside for investing.

Once you hit a month’s worth, set aside 10% of new revenues for investing.

Once you hit 6 months’ worth, set aside 15% (or 20%) of new revenues for investing.

If you haven’t already done so at 6 months’ worth, once you hit a year’s worth of expenses in your emergency fund, go to 20% toward investing.

Making Sure Money Set Aside for Investing Isn’t Frittered Away

At the start of each month, send to your investment portfolio every penny you set aside for investing during the prior month.

How you invest that money is beyond the scope of this article, but you can find a lot of information in other Medium articles, whether mine or those of many other finance and investing writers.

What About Repaying Debts?

Since so many Americans are in debt, this is a legitimate question.

For our purpose here, consider debt payments as spending that belongs in category K. Keep paying at least the minimum to prevent your debts from growing and your credit score from going down the drain.

To reduce your lifetime interest costs, pay more than just that minimum. To achieve that, if you have non-mortgage high-interest debt (e.g., credit cards), split the investment set aside above in two, and add that extra amount toward either your highest-interest or lowest-balance debt.

Once that debt is knocked out, add everything you were paying against that one to the next in line.

To figure out your personal best method of getting out of debt, whether “snowball” or “avalanche”, read this.

The Bottom Line

To escape the “paycheck to paycheck” trap that holds so many Americans (and others), disconnect the metaphorical firehose through which your money shoots out of your pocket from where you keep all your money. By making it harder to overspend, you gain control and safety.

Review all your spending and make sure it aligns with your goals and priorities, and that you’re not spending more than you need to on any specific service or product. That will reduce your monthly spending, and in turn free up money to build an emergency fund and invest for your future


This article is intended for informational purposes only, and should not be considered financial or legal advice. You should consult a relevant professional before making any major decisions.

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